Dear Dagen: Patience Pays Off for Jensen Fund

I have been looking at the (JENSX) - Get Report Jensen fund. It's a large-cap growth fund with a good record, and it's still small in terms of total dollars. Are you familiar with it?
-- Mike Manchester

There's been

so much talk about all the growth funds that have lost money over the past two years that it's easy to forget that there are some solid funds actually worth buying.

And the Jensen fund is one of them.

In fact, this fund is an anomaly. It's a large-cap growth fund that produced a positive return for the past seven calendar years. Jensen's three-year annualized return of 10.9% beats 99% of other large-cap growth funds. And its five-year numbers are just as impressive.

The fund's five managers run a concentrated portfolio of about 25 stocks; such a strategy was the downfall of many growth funds over the past two years. But these stock pickers pay careful attention to how much they pay for a growth stock. The managers first sift through about 10,000 publicly traded U.S. companies with returns on equity of at least 15% in

each

of the past 10 years. That screen cuts the list to about 110.

Then they winnow that list down to about 50 worth investigating. To make that roster, a company must have consistent earnings and free-cash-flow growth. The managers also want a company that's using its excess cash in ways that benefit shareholders, like buying back stock or paying down debt.

The Jensen managers then come up with their own estimate of each company's worth. And the team will only buy stocks trading at a discount of at least 40% to that calculation. "We're real patient, and we wait to buy them at a substantial discount to that value," says manager Bob Millen. "Our companies have the ability to perform over time and are bought at a margin of safety. You get upside benefit with downside protection."

The managers started buying credit card issuer

MBNA

(KRB)

last October. "The stock only went public about 10 years ago and just came on our list," says Millen. The company's average return on equity is more than 25%. It continues to grow its core business in the Americas and is pursuing growth in Europe and Canada, he says. Plus, it's expanding by making loans and taking deposits through the mail and over the Internet. "It has great management and a wonderful brand. And they don't miss their numbers."

Their sell discipline for their stocks is just as strict. Although "our preference is to hold them forever," says Millen. If a stock hits the managers' estimate of its intrinsic value, they will at least look at selling it. And they'll also sell if a company misses the 15% return on equity target in one year.

In short, the managers want a company to have a history of impressive growth and a stock that's not expensive. And that attention to growth and price kept the fund out of the tech stocks that have caused so much pain over the past two years.

When and if the market for ridiculously priced growth stocks comes back to life, this fund won't be sitting at the top of any ranking. Its 17% annual return in both 1998 and 1999 was decidedly tame. But Jensen's conservative approach and attention to valuation are attractive. Factor in the fund's small size (it has only about $300 million in it), tax efficiency and low expense ratio, and it looks even better.

In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to

Dagen McDowell.